`EXCESS EXUBERANCE' HARKS BACK TO THE HOUSING FRENZY OF THE 1990s.

In February, Tiff Macklem, the Bank of Canada governor, said the following when asked about the housing market: “We are starting to see some early signs of excess exuberance, but we're a long way from where we were in 20162017 when things were really hot.” (Emphasis ours.)

That was then. Canada's house-buying mob can travel a lot of ground in three months. A new assessment by the central bank shows the real estate frenzy is now probably more extreme than it was four years ago.

On May 20, the Bank of Canada released its annual Financial System Review (the FSR), which amounts to a checkup on the health of the country's network of banks, shadow banks, asset managers, traders and investment houses. It's a group over which the central bank has essentially no formal authority. But for one day at least, the FSR gives the governor a bully pulpit from which to attempt to exercise moral suasion.

Macklem flagged six “vulnerabilities,” or weak spots, that could cause the system to crumble if hit hard enough with an external shock, such as a recession or the failure of a big financial institution. Two of those vulnerabilities related to housing: the mountain of debt that households have piled up chasing runaway prices, and those runaway prices, which, in some big-city markets, the Bank of Canada thinks are being pushed higher by speculation and naive expectations that home prices only go up.

Notably, the Bank of Canada's most recent research suggests that the froth in at least some markets is now worse than in 2016 and 2017. Policy-makers reckon that households with mortgages that are 450 per cent bigger than their incomes are vulnerable to bankruptcy. That group represented 22 per cent of all home loans in the fourth quarter, compared with a previous peak of about 18 per cent in the third quarter of 2017.

The figure was 16 per cent at the end 2019, when households appeared to be slowly working off their debts. That trend has reversed. Canadians are again adding to their already impressive debt piles, which represent a risk to future growth.

A mismatch between supply and demand explains most of the surge in house prices, but there is some mania in those numbers. Macklem's February characterization of what he was starting to see in Canada's housing market brought to mind a famous description of stock markets in December 1996: “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

Those were the words of Alan Greenspan, the former chair of the U.S. Federal Reserve. It was widely assumed that Greenspan was attempting to signal his discomfort with the market frenzy over internet stocks. It didn't work. The dot-com bubble burst in early 2000. Good thing many of Canada's housing markets are only excessively exuberant, and not irrationally so.

Tiff Macklem